Summary
- Since 2020, insiders Masa Son, Jack Ma, and Joe Tsai have done nothing but sell shares of Alibaba.
- The trio has sold North of $40 billion of stock since 2020. Tsai recently registered to sell an additional $260 million.
- Competition from JD.com and Pinduoduo is beginning to squeeze Alibaba's core business. The company is also losing share in cloud.
- Despite this, I estimate long-term returns of 13% per annum.
Some Background
I've now written three "strong buy" articles on Alibaba ( BABA ). More recently, I bought BABA shares heavily on the reelection of Xi Jinping in China, as shares plummeted into the $60 range. Since then, shares have gained 85% in less than three months:
Why such extreme selloffs and extreme run-ups in the span of a few months? Because the market has no idea what it is doing with Alibaba shares. And, why should it? Many of the fund managers who own huge swaths of BABA stock don't live in China. They cannot see the competitive dynamics of Alibaba's business first hand. So instead of selling on business fundamentals, Alibaba shares swing wildly based on macroeconomic narratives. The latest is the "re-opening" of China following COVID-19 lockdowns.
I've since sold off all the shares I acquired in the $60 range, and, in this article, I will try to provide a more nuanced view of the microeconomic issues facing Alibaba. These fundamental issues may shed more light on why insiders are selling.
Keep in mind, some of the recent insider selling was, at least in part, due to cash flow issues at SoftBank . But, the totality of the selling requires further investigation. Let’s take a look.
Alibaba's Moat Is Deteriorating
In my first article on Alibaba, I wrote that the company faces competitive threats from JD.com ( JD ) and Pinduoduo ( PDD ). The main issues highlighted were that JD.com had faster shipping, and that Pinduoduo had lower prices through its group buying model. Looking back, this should have been more of a red flag. If you don't have the fastest shipping, and you don't have the lowest prices, what's your value proposition? This may be why Alibaba is losing market share year after year in China commerce. This is evident in the revenue growth of these three companies:
Notice that Alibaba is keeping pace with JD.com, but losing ground rapidly to Pinduoduo. At first glance, this doesn't look too bad. But, keep in mind, Alibaba bought another huge stake in Sun Art Retail ( SURRY ) in 2020. Sun Art Retail is a grocery store with huge revenues and low margins. This purchase added about $6.5 billion to Alibaba's revenue, totalling $131 billion. Without this, Alibaba's revenue growth would have trailed that of JD.com as well.
You can see Alibaba's lagging e-commerce growth in the figures below:
Alibaba's market share is also shrinking in cloud infrastructure. Alibaba had a 34% share in China's cloud market as of Q2, 2022:
This is down from 44.5% just two years earlier:
Here, Alibaba is losing ground to Tencent ( TCEHY ) and Huawei.
This isn't the only reason Alibaba's cloud growth is slowing. One of Alibaba's largest cloud customers, ByteDance ( BDNCE ), switched its international operations to Amazon's ( AMZN ) AWS. Also, China's mandating government owned companies to switch to government cloud services for data privacy. The South China Morning Post reported :
"Data security law: China orders state firms to migrate to government cloud services."
Does Management Have What It Takes?
While this isn't often discussed, I believe Alibaba is missing the leadership of Jack Ma. Jack was a charismatic and visionary leader. He brought troves of talented employees into Alibaba's headquarters. And, in technology, employees really matter. Now it seems Alibaba is losing its shine.
Daniel Zhang, the new CEO, is struggling with a vastly spread-out business. Alibaba subsidiaries like AliExpress, Youku, and Sun Art are struggling mightily. Alibaba's M&A team lost a lot of shareholder capital in the acquisitions of Sun Art and Youku. Neither company is currently profitable. In addition, Alibaba's trying to control each of its global subsidiaries. But, in doing this, the company isn't keeping up with diverse consumer needs. CEO Daniel Zhang has too much on his plate. Personally, I'd prefer to see a decentralized management structure, more like that of Berkshire Hathaway (BRK.A) ( BRK.B ) or Tencent.
Long-term Returns
First, let's looking at earnings. We need to understand that because of unrealized losses and write-downs, Alibaba's net income isn't a reliable representation of the company's true earnings power. Free cash flow is a better metric.
Over the past three years of reported earnings, Alibaba's averaged 134 billion RMB of free cash flow ($19.8 billion USD). This 3-year average is a better representation of Alibaba's true earnings. In 2022, economic conditions in China were very poor. Things are now looking up.
Going forward, much of Alibaba's growth will come from narrowing losses in its unprofitable segments:
Notice, China Commerce is Alibaba's only profitable segment. The reason for this: Chinese companies compete aggressively on price and Alibaba is investing heavily cloud, international commerce, and logistics.
In light of the issues highlighted in this article, I've reduced my 2033 price target for Alibaba to $380 per share, implying returns of 13% per annum.
- Because of the strong tailwinds in Alibaba's core industries, I believe the company is capable of increasing its free cash flow from $19.8 billion to $55 billion by 2033. I also expect Alibaba to buy back shares at 2% per annum, reaching 2.17 billion shares outstanding in 2033. Do the math, and this gives you $25.35 per share of free cash flow in 10 years' time. I've applied a terminal multiple of 15. This is my base-case scenario. There are risks to contend with, such as the VIE ownership and China's CCP.
In Conclusion
Alongside Alibaba insiders, I've reduced my expectations for BABA stock. Despite this, I maintain a "buy" rating on the shares and expect returns in the range of 13% per annum. Alibaba is losing market share quite rapidly. Competition from Pinduoduo, JD.com, Huawei, and Tencent has hindered Alibaba's growth. The company appears to be missing the charismatic and visionary leadership of Jack Ma. CEO Daniel Zhang's strategy may need to change in order to fend off competition and meet the needs of global consumers. At the same time, Alibaba's averaged $19.8 billion of free cash flow over the past three years and shows promise narrowing losses in cloud, logistics, and international commerce. We've trimmed back our exposure to Alibaba as the shares rallied 85% in less than three months. What do you think of the recent insider selling? I'd like to hear your thoughts.
Until next time, happy investing.
For further details see:
Alibaba: Why Insiders Are Selling